Delaware Targets Unclaimed Property

Delaware is known as one of the most business-friendly states in the country, a reputation that has led more than half of all publicly listed U.S. companies to incorporate there. But America’s first state has a harsh side: It is one of the most aggressive in calling dibs on “unclaimed property,” such as uncashed paychecks and unused gift cards, miring companies in years of audits and costing them millions.

Under Delaware law, companies incorporated there must turn over unclaimed property to the state if they can’t locate the owner. The state gets unclaimed securities and dividends after three years. For all other types of property, such as gift certificates, the state claims possession after five years.

The rule has long been criticized as a revenue scheme on the part of the state, and has spurred substantial pushback from the corporate community.

“You can’t be nice with one hand and slap us with the other,” said French Slaughter, a tax lawyer in the Washington office of McGuireWoods LLP, who has represented several companies audited by the state for unclaimed property.

Aware of the backlash, Delaware last summer rolled out a temporary voluntary-disclosure program, a sort of amnesty under which companies that feel they owe back payments to the state can calculate what they believe they owe and pay it without additional penalties. About 50 companies have signed on so far, said Delaware Secretary of State Jeffrey Bullock.

Skeptics say it is unlikely the state is ready to truly back off a program that has brought in $1.24 billion over the past three years alone, its third largest revenue source behind income and franchise taxes over that time.

“Unclaimed property is crack for the state of Delaware,” said Chris Hopkins, a partner at Crowe Horwath LLP.

Unclaimed property includes un-cashed payroll checks, unused gift cards or certificates, life insurance benefits, dormant bank accounts, and stock dividends, among other goods. The state liquidates the property and uses the revenue. If the owners later claim the sold property, the state simply turns over the cash.

Most states have some form of unclaimed property rule, but Delaware has been the most aggressive in going after companies, according to Diane Green-Kelly, a lawyer at Reed Smith LLP, who has represented several companies that have been audited by the state, including McKesson and Staples She said many companies feel as if they have complied with the law when they turn over unclaimed payroll checks or gift cards to the state, but are then surprised when the government brings in third-party auditors.

Compounding the problem: The state can look back to 1981 in its audits. If companies don’t have records back that far, Delaware then estimates the amount the state feels it is owed and piles interest and penalties on that legacy amount.

“It seems like a money grab to the companies,” said Ms. Green-Kelly.

The state expects to bring in roughly $566.5 million for the fiscal year ending in June. Last year, the state returned $18.9 million of unclaimed property to its owners and booked $319.5 million in revenue from the liquidated property. Delaware’s Secretary of Finance, Thomas Cook, said there are 300 audits under way in the state, which resolves roughly 50 a year.

An audit can be a long, expensive process CA Technologies in 2010 paid Delaware $17.6 million in an out-of-court settlement made five years after the state began its audit. Last year, Staples paid almost $9 million to the state to resolve an audit that began in late 2005. Both Staples and CA declined to comment.

State officials are becoming sensitive to the complaints. Last year, Delaware began its temporary voluntary disclosure program, under which companies need to look for unclaimed property only back to 1996, instead of 1981. If they satisfy the state that they aren’t hiding anything and remain compliant with state reporting guidelines for the next three years, the companies will be sheltered from being audited for prior years and avoid paying interest and penalties on past-due amounts.

The voluntary program, which runs through the 2015 fiscal year, is handled by the Secretary of State’s office, which is considered business friendly, instead of the department of finance.

“There was a recognition that we had to come up with a better system to meet the ultimate goal, which is to have companies in compliance,” said Mr. Bullock.

Delaware also temporarily stopped sending out new audit letters in July, Mr. Cook said. The department expects to resume sending out audit notices in about a month.

Todd Lard, general counsel for the Council on State Taxation, a group that lobbies local governments on tax issues on behalf of some the largest U.S corporations, called the state’s decision to run the voluntary program out of Mr. Bullock’s office “one step in the right direction.”

Correction: Chris Hopkins is a partner at accounting firm Crowe Horwath LLP. The article above originally misidentified him as a lawyer.

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